Loan book valuations – accounting standards’ greatest challenge

The Parliamentary Commission on Banking Standards recommended that the “expected loss “ model should replace the existing “incurred loss” model in IFRS – in other words, that the concept of “prudence” should be reinstated in the accounting framework.

In support, the European Parliament has instructed the European Central Bank to undertake stress tests on 124 major banking groups, and it seems that “expected loss” valuations will be applied since a majority of MEPS have threatened to withdraw 60 million euros of funding for the International Accounting Standards Board if prudence is not restored.

UK fund managers, by contrast, are keen to retain the IFRS incurred loss model for fear that they might actually have to “adjust data for a conservative bias”; and that any such change would leave them to make their own assessments of “how prudent management has been in presenting the accounts”.

Oh dear! To this astonishing reaction one can only observe that fund managers and rating agencies have had plenty of experience in adjusting accounts – not for excessive prudence, mind, but for the wilful myopia that indulged the preference of bank boards for vastly overvalued debts.

Auditors’ greatest challenge

The subjectivity of management valuations has always been auditors’ greatest challenge. Given that banks’ loan books were acquired in the first place as embedded elements in the game of “pass-the-poison”, it is surprising that audit methodology remains so averse to taking a peek inside the parcels of toxic derivatives.

Those slung out for such routine shortcomings as gross incompetence have not made it into these statistics

So it seems that the City’s preference is to continue to rely on bankers’ own assessment of the value of their loan books, despite the fact that close to 6,000 bankers and financial advisers have so far been sacked or suspended for dishonest conduct since the start of the banking crisis – and these are only the ones that “fit and proper” enquiries have actually found to have been caught stealing, cheating or lying. Those slung out for such routine shortcomings as gross incompetence have not made it into these statistics.

Despite the banks’ repeated message that lessons of the crisis have at last been learnt, the lure of sub-prime lending is again proving irresistible in the US, where these nasties always begin. Just as the state of California reports a 57% hike in 2013 foreclosure actions, the largest mortgage provider in the country, Wells Fargo Bank, has plunged straight back into lending to borrowers with credit scores that fail every creditworthiness test.

Could it really be different this time? Well, borrowers must now actually pay a deposit, suffer interest charges of 10%, and explain why their credit score is so low – presumably not counting the record of their chronic inability to repay loans. Here we have the very conditions which, it seems to me, guarantee another wave of defaults.

What about that neglected group, the savers? Although savings represent the pool of capital that bridges and reconciles differences in consumers’ time-value of money, their contribution remains unrewarded while government interference in capital markets suppresses interest rates to near-zero. The twofold effect is to give banks a windfall permit to fleece desperate customers, while forcing savers out of their safety zone into the speculative realms of stocks and bonds.

GDP mythology

Harmonising accounting standards of EU member nations is a helpful step towards eradicating legislative arbitrage. However, the latest venture, which will standardise components of national GDP statistics across all 28 countries, appears to be tainted with a political agenda. New methodologies will be introduced in September to standardise treatment of research and development, armaments expenditure, and costs of insurance and pension provision.

The EC’s table of impacts shows, however, that there are no losers. The standardising process will improve the GDP of every country by between 1% and 5% (up 3% to 4% in Britain’s case). This statistical bonanza will, of course, produce not so much as an electronic sausage – but what a boon for the Chancellor in an election year to be able to claim, for example, that taxation, debt and deficit as proportions of GDP have, well, miraculously improved.